OPEC’s Struggles
OPEC and a few other countries agreed to reduce production by 1.8 million barrels daily late last year and cheating was held to a minimum, so prices rose. But the price rise was not sustained, as increased domestic shale production offset much of the reduction in OPEC supply. OPEC is likely to agree to extend last year’s supply reduction and might even cut a bit more, yet this would merely leave the field open for increased output in North America. Fracking has fundamentally changed the industry. So, we see little potential for crude prices to rise on any sustained basis anytime soon. And should OPEC fail to keep production down, oil prices would plunge in response.
OPEC is caught between the proverbial rock and a hard place. In late 2014, the Saudis hoped that by increasing production and driving down prices, they could bankrupt many U.S. shale drillers, reduce U.S. production and restore prices to loftier levels. When that approach failed, they reverted to their old model of just cutting supply. They have cut production and kept cheating to a minimum successfully, yet they have been unable to reduce global supply or work down inventories adequately. North American producers are offsetting their efforts with increased drilling at ever lower costs. After falling to a low of 316 last year, rig usage has more than doubled to 712 rigs and climbing. Oil and gas coming out of the Permian Basin is already highly price competitive, but falling costs are increasingly supporting renewed drilling activity from other basins. No significant retrenchment in domestic production is likely unless oil prices take another tumble. So even as global energy demand increases at a 1.3 million barrel per day rate, increased production has limited the reduction in global output and global inventories. There should be some modest inventory reduction over the summer, as peak gasoline and air conditioning demand add some seasonal consumption, but the underlying plight of OPEC has not improved, which is very good news for consumers and manufacturers.
OPEC is soon likely to agree to extend its production cuts, if only because they have little choice. But even that has proven unsuccessful, since increased U.S. output has replaced withdrawn OPEC supply. Now they face a true dilemma. If they resume production, or if cheating becomes material, oil prices would collapse again. So they must hang on in the hope that growing demand will absorb the ever rising cheap energy supplies that are coming to market and hope cheating doesn’t increase. It is a very weak hand that they are playing. And in the meantime, we will continue to enjoy growing supplies that maintain a lid on pricing pressures, while our pipelines carry the increased volumes we are producing.
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